13. The payback period Aa Aa E The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Year 0 -5,500,000 Year 1 $2,200,000 Year 2 $4,675,000 Year 3 $1,925,000 Cash flow Discounted cash flow Cumulative discounted cash flow Consider the case of Cute Camel Woodcraft Company: Discounted payback period: Cute Camel Woodcraft Company is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Alpha’s expected future cash flows. To answer this question, Cute Camel’s CFO has asked that you compute the project’s payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year.
Which version of a project’s payback period should the CFO use when evaluating Project Alpha, given its theoretical superiority? O Complete the following table and compute the project’s conventional payback period. For full credit, complete the entire table. Note: Round the conventional payback period to two decimal places. The regular payback period The discounted payback period Year 0 -5,500,000 Year 1 $2,200,000 Year 2 $4,675,000 Year 3 $1,925,000 Expected cash flow Cumulative cash flow One theoretical disadvantage of both payback methods-compared to the net present value method is that they fail to consider the value of the cash flows beyond the point in time equal to the payback period. How much value does the discounted payback period method fail to recognize due to this theoretical deficiency? Conventional payback period: $3,627,448 $1,571,373 $2,210,774 $5,654,699 O O The conventional payback period ignores the time value of money, and this concerns Cute Camel’s CFO. He has now asked you to compute Alpha’s discounted payback period, assuming the company has a 7% cost of capital. Complete the following table and perform any necessary calculations. Round the discounted cash flow values to the nearest whole dollar, and the discounted payback period to the nearest two decimal places. For full credit, complete the entire table.
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